Good morning, everyone, and welcome to the FARO Technologies Third Quarter 2020 Earnings Call. For opening remarks and introductions, I will now turn the call over to Michael Funari at Sapphire Investor Relations. Please go ahead..

Thank you and good morning. With me today from Faro are Michael Burger, Chief Executive Officer, and Allen Muhich, Chief Financial Officer. Yesterday, after market close the company released its financial results for the third quarter of 2020. The related press release and Form 10-Q for the third quarter are available on Faro's website at www.faro.com.

In order to help you better understand the company and its results, management may make forward-looking statements during the course of this call. These statements can be identified by words such as expect, will, believe, anticipate, plan, potential, continue, goal, objective, intend, may, and similar words.

It is possible the company's actual results may differ materially from those projected in these forward-looking statements.

Important factors that may cause actual results to differ materially are set forth in yesterday's press release and in the company's Form 10-K for the year ended December 31 and Form 10-Q for the quarter ended September 30, 2020.

During today's conference call, management will discuss certain financial measures that are not presented in accordance with U.S. generally accepted accounting principles or non-GAAP financial measures. In the press release, you will find additional disclosures regarding these non-GAAP measures including reconciliations to comparable GAAP measures.

While not recognized under GAAP, management believes these non-GAAP financial measures provide investors with relevant period-to-period comparisons of core operations. However, they should not be considered in isolation or as a substitute for a measure of financial performance prepared in accordance with GAAP.

Now I'd like to turn the call over to Michael. .

Thank you, Mike. Good morning. Welcome to our call. I am pleased to report in the third quarter we saw improved performance as global economies continue to reopen and our customer resumed their capital investment plans.

On a geographic basis, revenue in the Americas, and Europe exhibited the strongest sequential improvement as many of our customers began to overcome the pandemic related challenges they face in the second quarter. Within Asia Pacific demand improved modestly of a relatively stronger second quarter base.

Within the end markets, the Architecture Engineering and Construction or AUC and public safety markets exhibited a sequential uptick as construction projects resumed and government agencies returned to a more normalized operating condition.

Service revenue begin to exhibit steady improvement throughout the quarter as many of our customers return to work, which allowed for both greater including person training opportunities and greater demand from time and material repairs.

While near-term demand remains below 2019 levels are increased activity is heightened our confidence that the second quarter represents the trough, and a slow recovery in the markets we serve is underway.

That said, we remain cautious as the global health conditions could deteriorate, and adversely impact our customer's business plans and purchasing decisions.

Shifting to the strategic changes we announced last February, our quarterly non-GAAP operating expense levels remain below our stated target and our go-to-market transition is progressing very well.

I am pleased that in the third quarter of 2020 despite the continued market softness, our annualized revenue per sales headcount increased nearly when compared to the first half of 2019. This is an initial indication of the increased sales productivity, we expect will result from the changes in sales structure.

As it relates to our software and solutions initiatives, we continue to make progress on harmonizing our existing software solutions into one cohesive platform. We are particularly focused on improving our customers time to decision through software enabled automation.

And we believe these increasingly sophisticated capabilities will enable long-term differentiation and greater customer value. To help accelerate our initiatives in the third quarter, we added two industry veterans to Faro's executive team to lead our software and our hardware R&D organizations.

In addition to complement our internal development initiatives, in August, we announced the acquisition of Advanced Technical Solutions or ATS, a Swedish based leader in three dimensional digital twin solutions technology.

ATS has had success in the automotive space and as a result, have agreements in place with several well known global automatic – automotive manufacturers.

We believe this acquisition enables Faro to accelerate the adoption of digital twin technology with high accuracy, three dimensional measurements allow capital-intensive industries such as automotive to meaningfully reduce their time to market risk profile and cost.

While digital twin technology is primarily used in large complex manufacturing environments, the ultimate value proposition we can provide is equally applicable to customers in the AEC, and public safety markets we serve. In today's world where people are increasingly looking for ways to create, and leverage virtual environments.

Our market leading digital twin accuracy can provide unique ways to remotely manage physical NFLs.

While it will take time for customer adoption to build, we believe the way in which the digital twin application manage leading edge hardware with innovative software exemplifies the types of opportunities we are looking to create with our software and solution strategy.

Nearly three quarters into the strategic transition including two quarters under a pandemic, I am proud of the efforts and resiliency of the entire Faro team. With the new organization and processes largely behind us, and cost reduction goals realized, we are now shifting our focus toward accelerating revenue growth.

With that, I will turn the call over to Allen for an overview of our third quarter financial results..

Thank you, Michael, and good morning, everyone. Third quarter revenue was $70.7 million was down 22% when compared to the third quarter of 2019. As a result of continuing market softness caused by the pandemic.

As Michael indicated earlier, in the third quarter, we saw improving demand conditions that began in June, and continued throughout the quarter. As a result on a sequential basis bookings of $72 million were up 17%, and total revenue was also up 17%.

Service revenue increased to 24% sequentially as customers re-engaged on repair, and on-site training activities, while product revenue of $48 million was up 14% sequentially.

While pleased to see a healthy sequential demand increase of the second quarter lows, we continued to believe that the recovery in the markets we serve, borrowing any unforeseen pandemic impacts will lead to a gradual demand improvement over the coming quarters.

GAAP gross margin was 51.3%, and non-GAAP gross margin was 51.5% for the third quarter of 2020. While gross margin remains lower than last year, it did improve sequentially due primarily to the increased revenue and its positive effect on fixed cost absorption.

GAAP operating expenses were $41.2 million, and included approximately $2.5 million in acquisition-related intangible amortization and stock compensation expenses and $240,000 in restructuring costs. Non-GAAP operating expenses of $38.5 million were $12.6 million lower than Q3 of 2019.

As the company benefited from cost savings related to restructuring actions taken earlier in the year, and lower travel expenses given the current environment.

Non-GAAP operating expenses increased sequentially primarily as a result of variable compensation on higher revenue as well as R&D investments were making into our software and hardware roadmaps.

GAAP operating loss was $4.9 million for the third quarter of 2020 or 1 million better when compared with an operating loss of $5.9 million for the third quarter of 2019 with our lower expense base more than offsetting the soft demand environment. Adjusted EBITDA was approximately $800,000. Our GAAP net loss was $3 million or $0.17 per share.

Our non-GAAP net loss was $1.3 million or $0.08 per share for the third quarter 2020 compared to non-GAAP net loss of $0.01 per share in Q3 of 2019. We continue to maintain a strong capital structure with a cash balance of $163.6 million and no debt.

In the third quarter of 2020, cash decreased by $10.3 million primarily driven by changes in working capital, and the ATS acquisition, Michael mentioned earlier.

I would also like to note that, despite the soft demand environment, our current inventory balance has decreased steadily throughout 2020 by a total of nearly $9 million or over 14% when compared to December of 2019.

Our global operations team has done a fantastic job improving our inventory management practices, and we expect further inventory reductions in the future that will result from their efforts. This concludes our prepared remarks. And at this time, we'd be pleased to take any of your questions. .

[Operator Instructions] And we'll take our first question from Greg Palm with Craig- Hallum Capital. Please go ahead..

Hey, Michael, Allen, good morning..

Good morning, Greg..

Maybe you if can start by talking about the cadence of orders or just sort of overall demand activity through the quarter and you mentioned I think AEC and public safety is maybe some out sized strength, but any maybe end markets or other verticals that maybe surprised due to the upside..

I don't think there were surprises.

We had a relatively strong Q2 recovery in 3D metrology primarily driven out of Asia, and we mentioned in the call that Asia's sequential growth was probably as a percentage less than North America and Europe, because we had a relatively strong – stronger Q2 than in North America, and in Europe, based on historical rates.

So I think Asia recovered first, I was pleased by the recovery in Europe, we were a bit concerned, certainly Q3 is traditionally a slower quarter in Europe based on vacations, and they are anecdotally there were a number of our customers that kind of extended the vacation period, so we had concern, but it actually ended up in a pretty strong.

We do still have that kind of in the quarter dash, albeit, I think this was a little bit more deliberate, and so we felt the momentum really kind of begin to build in August, and it and it looks like it's continuing into the fourth quarter..

In the emerging, I might add is that – the other thing that the demand across our end verticals also was relatively good, and as Michael indicated, we did see an uptick in the public safety, and agency market that affected our scanner business a little bit more than what we saw in the arm. .

Okay, Okay, good. And this end of quarter dash, I mean usually Q4, and I guess December specifically I mean that tends to be a very big driver of business, I mean, certainly we're not in a normal year. But, how are you thinking about things, given your customer conversations.

Can you, so what you're seeing thus far in October as well?.

No, I think, we're encouraged that companies are coming back. I think that the $99 question is what typically has happened traditionally, and traditionally, and again this is my second year at the company.

But, what happened in 2019 is capital budgets that weren't spent, were spent in Q4 spend it or lose it capital, I guess, I would call it phenomenon. It is difficult for us to assume that that's going to happen again. We're cautiously optimistic, but I would say that we don't expect it to be as robust as it has been in past years.

But again, we don't really know this is kind of uncharted waters. It is great to see our customers coming back in mass, and our ability to have face-to-face meetings, and face-to-face demos, and that type of thing is becoming easier, which I think should bode well for us.

But I think, we do not believe that Q4 will bounce back to a Q4 2019 level, but we do see it, we do see some strength over Q3..

Okay. I just want to sneak one more in. I didn't hear anything, maybe I missed it, but on the virtual demos, I wanted to focus in on that, because I think that's somewhat differentiated maybe gives you a leg up versus some of the other competitors. I mean looking back on this past quarter.

I mean do you feel like that's a tool that can help you gain share did it may be going forward I mean especially in the environment we're in. .

Absolutely. We re-track both virtual and in-phase demos as one of the indices around productivity, and virtual demos continues to be a tool that, I think has now been inculcated in our sales culture. But, I would argue also perhaps in our customers' culture, which I think is very positive, and to your point I think bodes very well for Faro..

Okay. Thanks for the color. Best of luck Allen. .

Thank you..

Thanks Greg. .

Thanks Greg. I appreciate it..

And we’ll take our next question from Jim Ricchiuti with Needham. Please go ahead. .

Hi, good morning guys. You may have commented on this, I may have missed it. But can you speak to what you're seeing on the service side of your business.

I mean if I look at the year-over-year decline fairly modest, and I'm just wondering, is that part of this new go-to-market strategy where you are a little bit more successful on the service side of the business in terms of showing that area of the business. .

Yes. Services definitely a big part of our business, and it's been a focus for us particularly through quarter-and-a-half in terms of really streamlining the processes ensuring that we've got the best user experience.

I think what's really driving the revenue today in terms of reference to Q2, is really the fact that a lot of our customers are just coming back, and when calibrations or machines that needed repair, didn't really get shipped up, because frankly nobody was using it, that were in their factories with people coming back.

That's, I think, we come back to more normal levels. Training has also been a big part of our service efforts, and certainly there was, there was a lot of virtual training being done in Q2, but we actually saw an increase in person training, which virtual training is fantastic but you really can't get hands on.

So, in person training is obviously the best. And so, we saw, we saw a resurgence there. So I think I wouldn't say that it's going to change in terms of the dollar mix in favor of service over product revenue. I just think that is returning to kind of more normalized levels faster than product revenue has based on where we started in Q2. .

Got it. And Allen, how should we think about that, the components of OpEx going forward, is there, you had a bit of an increase on the R&D side sequentially.

Is this a level of R&D that we should be thinking about as a base going forward or whether – was there anything unusual in that R&D number?.

There wasn't anything unusual in the R&D number. And I think as we indicated in prior calls that we are adding to our resource level to be able to deliver both our hardware as well as software road maps. I think from an overall operating expense level.

Certainly, it was R&D, which you can see the results of some variable compensation built-in for the increased revenue, as we expect and looking-forward, I think we, as Michael just indicated, we expect the fourth quarter to increase revenue a little bit more from where it is in the – in the third quarter, and therefore would expect operating expenses to tick up again.

Again, with continued hiring as well as the variable compensation both affecting us in Q4, as well as Q3. So, a bit of a further uptick, but certainly well within the success model that we talked about back in February. Please. And last year, I guess James – please….

I was just going to. I was just going to add Jim that I think during the pandemic, we, we were very cognizant of the project spend. And the, the head count spends that were – we were kind of already underway in Q1 before this thing hit.

And so we slowed a lot of spend in a lot of areas around the Company, but we were very prudent in terms of cutting expenses and run rate expenses in R&D through this pandemic. In other words, we kept running as hard as we could in R&D..

And final question, just we're hearing more and more of that signs of recovery in the automotive market here.

And just wondering what you're seeing across your geographic regions, and in fact that's consistent with what we're hearing?.

Well there is a lot of activity. The question is, are they pulling capital triggers, and I think there is still some reticence. Automotive has come back, albeit not as strong at least in Q3, as we saw a recovery in public safety and construction.

But again as we mentioned, we saw Q2 probably a little bit stronger in terms of 3D metrology versus public safety and E&C. I think companies coming back to work is a lot different than spending money on capital. And I think factories are coming back and back online, and I think that bodes well.

But I don't expect Q4, to be back at 2019 levels even though I think many of the automotive factories are back and ramping..

Okay, fine..

The think that I might add it, automotive guys that we are engaged with on the digital twin side appeared to be also very active.

And so again, I think we're making relatively good progress on that front, which isn't necessarily going to be all capital in nature, which again I think will give us a slightly different flavor of the automotive market than what we've had historically, which is why one of the reasons we're excited about it. .

Got it. Thanks very much..

Thank you, Jim..

[Operator Instructions] And we’ll take our next question from Andrew DeGasperi with Berenberg Capital. Please go ahead..

Great, good morning. .

Hi, good morning..

I just had two quick questions. First, I was just wondering if you noticed any change in the competitive environment on the manufacturing side, particularly with, as it relates to the products from the arm and the scanner.

And then, secondly, I was just wondering if you could expand a little bit on ATS in terms of what the impact would be to revenue or on the, on the bottom line and expand a little in terms of what that asset will do to help you bridge on the digital twin side?.

Yes, from a competitive perspective not big changes, we we've commented I believe in Q2, that the competitive scenario seems to be less than typical, and by typical who knows what that means? I would reference probably Q3 or Q4 of 2019.

We have, we do see pockets of super aggressive pricing, I won't say across the board from our traditional competitors. So nothing that we that surprised us from a competitive perspective.

I think there is a new competitor for 3D metrology in Asia, and we've run across a new order manufacturer in Asia, but frankly hasn't caused us any consternation to date. But it is a competitive market particularly in 3D metrology, so we keep our eyes out, but we're not – nothing dramatic that is changed competitively in Q2 or Q3, so far.

Digital twin and the acquisition of ATS is really what – albeit a business what we really wanted from was what they bring in terms of their knowledge of workflow, and they've been very successful in Europe with several car manufacturers and effectively becoming a digital twin provider, which includes using Faro equipment creating a data set, and then hosting that data set on a cloud-based environment, and that is actually our, in-state.

So they have been a partner of ours for over a decade. And so, it made a lot of sense for us to inculcate them into Faro, take their workflow and being able to leverage their capabilities beyond just several car manufacturers that they're currently involved in.

As we said in the script, we also believe the digital twin is applicable beyond 3D metrology. We believe that there is applications in public safety around catastrophe planning or public facility mapping. And also, when you see around building, building ownership, and building management.

So we believe that this application, we don't see it as a separate market, but we see there's an application that is applicable in 3D metrology obviously in automotive, and in very complex manufacturing, but also in AEC in public safety, and these guys bring with them a decade plus of the experience, and really developing a workflow that is repeatable super accurate, and it has utilized Faro equipment.

So it was like a marriage for us and we're very excited. Our objective is to leverage what they know into the markets that we discussed. And the third question I forgot what that was..

Yes, I was going to ask and I'm not sure if it's de minimis or not, but like in terms of any quantifiable impacts to your top line.

And but as a follow-up to what you just mentioned I mean, do they bring software to the table in other words, is there a software component that potentially it helps on the digital twin side in other words, do they do something like what Ansys and others do on the assimilation where they tried to essentially provide some kind of digital image of the product, and sort of simulate real time stresses on that over time?.

From a revenue perspective, it's relatively de minimis, not very important – not very important at this time. We think that the opportunity in the market is huge and growing. And I think what they bring to us is software. And as I mentioned workflow, the software actually is not simulation software its measurement software.

And basically allows the point-cloud to be viewed in a virtual environment, very easy, and very quickly, and we're inculcating what these guys have developed into our software suite.

And we are very anxious in terms of taking their work-flow understanding and being able to spread that to new manufacturers that haven't seen the Faro digital twin application yet..

That’s helpful Michael. And from my last question, I just wonder if you can update us on the product road maps for the next six to twelve months. Just getting an idea in terms of what we should expect inclusive new releases..

Well today, for this year 2020 we've introduce three new products, we expect to introduce two more before the end of the year. I won't say what they are, but two what I would consider major product releases before the end of the year.

We are working very diligently to create a drumbeat if you will of new products, and we mentioned in the call that we've hired two new executives that report directly to me. One in charge of hardware engineering and one in charge of software engineering.

And so part of their challenge and charters really to create this drumbeat in which customers can expect differentiated new products on a much more regular, and frequent basis than we've done in the past. .

That’s helpful, thank you..

You are welcome. Thank you. And there appears to be no further questions. At this time, I will turn the call back over to Michael Burger for any additional or closing remarks. .

We appreciate everybody's attention this morning. We're very excited about where we are. It's great to see the business beginning to recover back to, I would think 2019 levels ultimately but, but we don't believe this is the recovery, we think this is a slow, and steady recovery and Q3 is an example of that.

We look forward to giving you an update next quarter. Thank you for your attention..